Source: Wind
Recent comments from Fed officials have added to uncertainty about the magnitude of the tightening, with a steeper yield curve suggesting bond traders are reducing bets that excessive Fed tightening will stifle economic growth.
The jump in U.S. inflation-adjusted bond yields is close to turning positive as the Federal Reserve aggressively tightens monetary policy, putting further pressure on riskier assets in financial markets.
Real yields on 10-year U.S. bonds have risen more than 1 percentage point since early March, hitting a high of -0.05% on Monday, according to the Financial Times, a sign that bond payments are about to outpace expected inflation—if This will be the first time since March 2020.
“The Fed will drain liquidity,” said David Lefkowitz, head of U.S. equities at UBS’s chief investment office. “When the Fed adds liquidity, those areas of the market that are more speculative benefit the most, and when the Fed reverses it They [may] face some… headwinds as they go their way.”
Real yields on ultra-low-risk U.S. Treasuries have plunged into negative territory in 2020, sparking a race for assets that still offer higher returns after accounting for inflation. Shares of money-losing start-ups and fast-growing tech companies have thus risen sharply from the trough in March 2020, and high-risk corporate debt has also risen sharply in late 2021.
This year’s surge in real yields, however, has prompted investors to reassess whether it’s worth owning shares in companies that may not generate huge profits for many years. Goldman Sachs said some private start-ups have agreed to cut valuations, while shares of money-losing tech companies have fallen more than 30% this year.
The S&P 500, one of the benchmarks for the performance of the U.S. stock market, is down more than 7 percent so far this year, as rising real yields, high inflation and uncertainty over the conflict between Russia and Ukraine have investors jittery. In the corporate bond market, an Ice Data Services index that tracks returns on U.S. junk bonds fell 6.3% over the same period.
The jump in real yields this year reflects a surge in nominal yields driven by Fed tightening. The 10-year U.S. Treasury yield hit 2.899% on Monday, its highest level since December 2018. After raising rates by 25 basis points in March, the Fed is expected to make several more rate hikes for the rest of the year.
The Fed is believed to be a certainty at its next monetary policy meeting in early May to raise interest rates by 50 basis points, and may begin to shrink its balance sheet to prevent runaway inflation, followed by a 50 basis point hike at its next meeting in June.
St. Louis Fed President James Bullard, a hawkish representative of the Fed, even said on Monday that the possibility of a 75 basis point rate hike by the Fed cannot be ruled out, although this is not his base case scenario. Bullard has voting rights on the Federal Open Market Committee (FOMC) this year.
U.S. Treasury yields rose more than inflation expectations, signaling investors’ confidence in the Fed’s ability to reduce troubling levels of inflation in the years ahead. The 10-year breakeven inflation rate, which measures market inflation expectations, has remained around 2.75% to 3% in recent weeks, well below the 8.5% U.S. consumer price (CPI) inflation rate in March.
“There is reasonable confidence in the Fed’s ability and willingness to fight inflation,” said Ian Lyngen, capital markets strategist at Bank of Montreal. “The question is not whether the Fed’s response is properly adjusted to current inflation, but the market. Participants believe the Fed will adjust policy if necessary. ”
The rise in real yields also shows the Fed’s ability to tighten financial conditions. Not only are borrowing costs for businesses soaring, but so are mortgage rates for consumers. The average U.S. 30-year mortgage rate hit 5 percent for the first time since early 2011, according to Freddie Mac data, following a rise in 10-year U.S. Treasury yields.
Despite the rise in interest rates, financial conditions “remain quite accommodative,” said John Madziyire, a portfolio manager at Vanguard. “That could mean more from the Fed, but it’s too early to tell.”
Economists are divided on how much upside is left given the current rapid rise in real yields, but some warn that yields could jump again given the Fed’s attempts to curb inflation.
Higher yields also prompted Barclays analysts to abandon their long 10-year strategy. The bank’s Anshul Pradhan wrote in a Monday note that recent comments from Fed officials have added to uncertainty about the magnitude of the tightening, with a steeper yield curve showing bond traders are lessening their belief that excessive Fed tightening will stifle the economy A bet on growth.
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